Real Estate Investment Trust How To Start – A Real Estate Investment Trust (REIT) is a company that owns, manages or provides income. By law, 90% of the REIT’s profits must be distributed to shareholders as dividends.
Many REITs lease space and collect real estate, then distribute the money to shareholders as dividends. Mortgage REITs (also called mREITs) do not own real estate; Instead, they pay rent. These REITs earn interest on their investments, including mortgage loans, mortgage-backed securities (MBS) and other related assets.
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To qualify as a REIT, a company must comply with certain provisions of the Internal Revenue Code (IRC). In particular, a company must meet the following requirements to qualify as a REIT:
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Companies with REIT status avoid corporate income tax. A typical company earns profits and pays taxes on all of its profits, then decides how to allocate its taxable profits between dividends and reinvestment. A REIT distributes only or nearly all of its profits and avoids taxes.
There are many different types of REITs. Equity REITs specialize in owning certain types of real estate, such as apartments, commercial real estate, offices, or residential/recreational properties. Some are different, some defy classification – for example, REITs only invest in golf courses.
Another major type of REIT is the mortgage REIT. These REITs finance loans from real estate, but generally do not own or manage real estate. Mortgage REITs require special evaluation. They are financial institutions that use various hedging instruments to manage interest rate risk.
Although a small number of hybrid REITs do real estate business and deal with mortgage loans, most REITs are REIT types that focus on the “hard asset” business of the real estate business. When you read about REITs, you usually read about equity REITs. Therefore, we will focus our analysis on equity REITs.
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REITs are dividend-paying stocks that focus on real estate. If you’re looking for income, you should consider them alongside high-yielding mutual funds and dividend-paying stocks. As stocks that pay dividends, REITs are evaluated like other stocks. But there are some big differences when it comes to pooling resources.
Traditional measures such as earnings per share (EPS) and price-to-earnings (P/E) are not reliable methods for measuring REIT debt. Earnings from operations (FFO) and adjusted earnings from operations (AFFO) are better indicators.
Let us explain with a simple example. Let’s say a REIT buys a house for $1 million. Accounting law requires our REIT to calculate depreciation and amortization. Let’s say we spread the depreciation on a straight line over 20 years. Each year we deduct $50,000 of depreciation expense ($50,000 per year × 20 years = $1 million).
Let’s look at the simple balance sheet and income statement above. At year 10, our balance sheet shows the building’s value at $500,000 (ie, book value), which is the original cost of $1 million minus the depreciation of $500,000 (per year for 10 years × 50,000) . On our income statement, $190,000 of the expense is deducted from the $200,000 income, but $50,000 of the expense is depreciation expense.
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However, our REIT does not amortize this amount over 10 years – amortization is a non-reimbursable expense. So we add depreciation expense to net income to get cash flow from operations (FFO). The idea is that deflation is disproportionately reducing our income because our homes haven’t lost half their value in the last 10 years. FFO corrects this assumed deviation by excluding depreciation expense. FFO also includes various other variables.
We should note that FFO is closer to investment than free cash flow, but it does not hold cash. Basically, notice in the example above that we never counted the $1 million (capital cost) that went into acquiring the house. A fair analysis involves financial costs. Calculating the capital budget produces a figure known as adjusted earnings from operations (AFFO).
Our conceptual balance sheet can help us understand another common REIT metric: net asset value (NAV). In 10 years, the book value we got was only $500,000 because the original material was cut in half. Therefore, related ratios such as book value and price to book—which are often suspect in normal stock analysis—are almost irrelevant for REITs. NAV seeks to replace the property’s book value with a better market value.
Calculating NAV requires a personal evaluation of REIT shares. In the example above, we see that the property generates $100,000 in operating income ($200,000 in income less $100,000 in operating expenses). One way would be to get the income from the job based on the market rate. Considering that the current market capitalization rate (the highest rate) for this type of house is 8%, then our estimate of the value of the house is $1.25 million ($100,000 in operating income ÷ 8% cap rate = $1,250,000). . ).
Reit Concept. Real Estate Investment Trust. Vector Line Art Illustration. Stock Vector
The estimated market value represents the book value of the property. We will subtract the borrowing costs (not shown) to get the NAV. Debt minus assets equal equity, where “net” in NAV means net of debt. The final step is to divide the NAV by the common shares to get the NAV per share, which is an estimate of the intrinsic value. In theory, the quoted share price should not deviate from the NAV per share.
When you pick stocks, you sometimes hear upside and downside analysis. It starts with a high-level economic analysis and a bet on a topic or sector (for example, an aging population can support the pharmaceutical industry). Focus on the fundamentals of a specific company. The REIT business clearly requires top-down and top-down analysis.
From the top down, REITs can influence anything that affects the supply and demand for real estate. Population and employment growth are positive for all types of REITs. In short, interest is a mess.
A rise in interest rates generally means the economy is improving, which is good for REITs as people spend and businesses give up space. Rising interest rates are good for condominium REITs as people choose to rent rather than buy new homes. On the other hand, REITs can often take advantage of lower interest rates, reduce interest expenses and thus increase their profits.
What Is The Real Estate Investment Trust, Or Reit
Because REITs buy real estate, you may see higher fees than other types of companies. Be sure to compare the REIT’s debt levels to industry averages or debt ratios for competitors.
Capital market conditions are also important, namely corporate demand for REIT stocks. In the short term, this desire can overcome the fundamentals. For example, REIT stocks performed well in 2001 and the first half of 2002 despite weak fundamentals, while funds flowed into the entire asset class.
At each REIT level, you want to see strong prospects for revenue growth such as rental income, related operating income and FFO. You want to see if the REIT has a unique strategy to improve living standards and increase rents.
REITs often seek to grow through acquisitions and seek to gain economies of scale by acquiring less controlled assets. An economic ratio will be achieved by reducing wages as a percentage of revenue. But acquisition is a double-edged sword. If the REIT is unable to raise housing prices and/or increase rents, it may be forced into negative acquisitions to increase growth.
How To Form Reit?
Since mortgage payments play a large role in the cost of equity, it’s worth looking at the balance. Some advocate looking at leverage as the ratio of debt to equity. But in practice, it’s hard to tell when an investment is too much. It is important to check the balance of fixed rate fees and variable rate fees. In the current low interest rate environment, REITs that use only floating rate debt will suffer if interest rates rise.
Most REIT dividends are not what the Internal Revenue Service (IRS) considers qualified dividends, so they are often taxed at a higher rate. Depending on your tax bracket, qualifying tax is charged at 0%, 15% or 20%. However, with REITs, most dividends are taxed as ordinary income – up to 37% for 2021.
Generally, REITs are taxed like ordinary income. Therefore, it is recommended that you hold REITs in a tax-advantaged account such as an individual retirement account (IRA) or 401(k).
However, there may be good news here. Because REITs are pass-through entities, any shares that are not considered qualified shares may qualify for a 20% business income (QBI) deduction. For example, if you have $1,000 in regular REIT distributions, you may be taxed on $800 of that.
Real Estate Investment Trust Vs Direct Purchase Properties
Why choose funds from operations (FFO) or adjusted funds from operations (AFFO) when evaluating real estate investment trusts (REITs)?
Traditional stock measures, such as earnings per share (EPS) and earnings-to-earnings (P/E) ratios, are often not a reliable way to determine the value of a real estate investment trust ( REIT). Instead, REIT investors use earnings from operations (FFO) or adjusted earnings from operations (AFFO), both of which adjust for depreciation and require dividend payments.
REITs consist of real estate investments that mature over time
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